Why Short-Term Loans Have Higher Interest Rates

People who take out short-term loans will pay a higher interest rate than those who take out loans for a few years or more. The reasons for that depend on factors, such as from where the money was sourced, the type of the loan, and the schedule for paying it back. The source of the money is the biggest factor. If the money comes from a bank or credit union, the interest rates will be the lowest available. Non-traditional lenders will charge higher interest rates.

Volume business is one reason banks and credit unions can charge less. Most people get their loans from those two traditional lenders. The low interest rate is enough to cover the risk, contribute to overhead expenses, and allow the lender to have capital to continue lending out money. Even in a bank, interest rates will be higher for short-term loans than for long-term loans. Those lenders also have other means of taking in income. Credit cards, checking and savings accounts, certificates of deposit (CDs), business accounts, and investments, also bring in a source of revenue.

Non-traditional lenders, such as pawn shops and fast cash businesses, lend money to make money. Their overhead, which includes staffing, advertising, rental of the building, and equipment, is covered solely by the loans they approve. The higher rate provides a profit. The rate is also higher because they take bigger risks by loaning to people with low credit scores. Convenience is another reason people pay higher interest rates. Money is available 24/7 in most cases, and it is provided quickly.

The type of the loan is also a factor in interest rates. Personal loans from a traditional lender have higher interest rates than specific loans, such as those for a vehicle or mortgage, because there is typically no collateral required. Title, installment, short-term, and payday loans from other lenders will vary in rates. Part of the increase in interest rates for short-term loans stems from the small number of payments made. A loan taken out for six months, for example, leaves little time to gain revenue on that transaction. The higher rate makes the effort, risk, and paperwork that goes into a short-term loan worth the trouble for lenders.